Yesterday, Sunway REIT (SUNREIT) announced that the trustee, the manager and Sunway Putra Hotel Sdn Bhd (SPHSB) had on 5 January 2012 entered into a supplemental agreement to the Hotel Master Lease to document the agreement reached by the parties on the guaranteed rent payable (33.6% lower for FY14) by SPHSB, in light of a major refurbishment being carried out on the adjoining Sunway Putra Mall. We are not totally surprised by this news as we understand that the performance of Sunway Putra Hotel is likely to be adversely affected due to the major refurbishment. Nonetheless, given the net differential amount of the adjusted rent is only about 1% of SUNREIT’s full year earnings for FY14, we leave our forecasts unchanged now, pending its 4QFY13 results. Hence, we keep our NEUTRAL recommendation unchanged with a DDM-based TP of RM1.56.

What’s in the news
Yesterday, SUNREIT announced that the trustee, the manager and Sunway Putra Hotel Sdn Bhd (SPHSB) had on 5 January 2012 entered into a supplemental agreement to the Hotel Master Lease (First Supplemental Agreement) to document the agreement reached by the parties on the guaranteed rent payable by SPHSB, in light of a major refurbishment being carried out on Sunway Putra Mall, a shopping mall situated on the adjoining property to the hotel commencing from 1 May 2013 for an estimated period of two years therefrom which will adversely affect the business of SPHSB.

SPHSB has appealed to the manager and the trustee for a variation to the guaranteed rent. The manager and the trustee have agreed to enter into a second supplemental agreement to the Hotel Master Lease (Second Supplemental Agreement) to vary the guaranteed rent under the First Supplemental Agreement.

Pursuant to the Second Supplemental Agreement, the parties agree to vary the guaranteed rent for 3rd fiscal year (FY14 for SUNREIT), with the total rent payable by SPHSB to the trustee shall be the amount calculated in accordance with the variable rent formula under the Hotel Master Lease.

If the variable rent calculated is less than the amount of the guaranteed rent for the 3rd fiscal year, the difference (estimated at RM3.3m/ 33.6% of the guaranteed rent) between the guaranteed rent and the variable rent shall be adjusted in agreed proportions to the guaranteed rent from the 5th fiscal year until the 11th fiscal year, which shall be mutually agreed and documented by the parties in writing to supplement the Second Supplemental Agreement.

The same variation to the total rent payable by SPHSB to the Trustee may apply to the 4th fiscal year (FY15 for SUNREIT) if requested in writing by SPHSB on the basis of continuing adverse operating conditions caused by the major refurbishment work at Sunway Putra Mall.

Our comments
We are not totally surprised by this news as we understand that the performance of Sunway Putra Hotel is likely to be adversely affected by the major refurbishment of the adjoining Sunway Putra Mall.

Nonetheless, given the net differential amount of the adjusted rent is only approximately 1% of SUNREIT’s full year earnings for FY14, we leave our forecasts unchanged now, pending its 4QFY13 results.

Valuation and recommendation
Hence, we keep our NEUTRAL recommendation unchanged with a DDM-based TP of RM1.56.
Key risks include (1) rising interest rate which could result to higher cost of equity that undermine our DDM valuation model, and (2) sharp economic slowdown which affect domestic consumptions and investment activities.

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